Paying the right price for oil

June 19, 2004

HERE’S the sticky truth about oil: As a finite commodity, the world never seems to tire of burning more of, its price is bound to hit the roof.

What keeps that fateful day from being pushed far into the future, however, is where most petroleum exports come from — the Middle East, not the easiest of regions to feel secure about at the best of times. Add terrorism to the mix of variables and you have a recipe for even more volatility. Last month, the markets placed a US$5-$8 “fear factor” premium on benchmark crudes, sending oil prices above US$40 a barrel, their highest in over two decades. The lesson of the 1973 oil shock, when prices trebled almost overnight and the world economy slumped, returned with a shiver.

Comparisons with 1973 are, of course, a little overblown. Then, Saudi Arabia led a cartel to punish the West for its support of Israel in the Yom Kippur War over Palestine. Today, the reasons for the market’s jitteriness are more transparent. Oil exporting countries are producing flat out to meet demand, leaving Riyadh’s role as swing producer even more critical. The Saudis employ their vast capacity to moderate prices, as they did earlier this month by the decision to increase their production quota within Opec. Because of this pivotal position, however, perceptions of their vulnerability to terrorist attack can exert a disproportionate effect on an already very tight supply-demand scenario.

Thankfully, such scares are also overblown. The Saudi Government is much better equipped to protect its oil facilities than its critics suggest. In a nod to this assessment, oil contract prices climbed down to the mid-30s last week. Nevertheless, the motives for Saudi Arabia’s action in 1973 haven’t gone away. On the contrary: They have been taken up by Osama bin Laden and his cohorts, whose rallying cry is that Muslim oil wealth is being sucked away to perpetuate injustice in Muslim lands.

Indeed, the exploitation of oil in the Middle East has had a shameful history, rife with big power bullying and dirty dealing. At the Asia Oil and Gas Conference in Kuala Lumpur last Monday, Prime Minister Datuk Seri Abdullah Ahmad Badawi, in a speech read out by Datuk Seri Najib Razak, reminded his audience of how much politics still matters. “It would be remiss of me to talk about the challenges facing the oil and gas industry and issues such as security of supply without making reference to the Middle East,” he said. “The recent developments outlining the transfer of full sovereignty to the Iraqi people is therefore a welcome step towards normalising the situation in the region, although true peace cannot be achieved until the Palestinian issue is resolved in a fair, lasting and equitable manner.” Even without the headline-grabbing violence of terrorism, oil will remain a contentious and divisive issue in the Middle East, which owns two-thirds of global reserves, unless such a resolution is found.

Abdullah also addressed a subject of nearly equal concern — that of demand. Developing countries, particularly China and India, are consuming oil at a faster rate of increase than the rich countries. No one can question their obligation to lift themselves out of poverty. Less justifiable, however, is their energy inefficiency — poorer countries use more oil per unit of GDP, usually with government subsidy, than even the greediest of consumers, the United States.

Although the world is not about to run out of fossil fuels, the argument for price signals to work more sharply is compelling. The silver lining from the experience of 1973 was in the drilling of oil in areas where it would not have otherwise been economic, such as in Britain’s North Sea and off the coast of Terengganu. Prices will have to remain high if such sources, including the ultra-deepwater finds announced by Petronas recently, are to be brought on stream. Consumers ought to be mindful of this, instead of protesting every two sen increase in the cost of a commodity that is clearly not going to last forever.


Tags: Consumption & Demand, Fossil Fuels, Oil